Archive for the ‘CDO’ Category

U.S. criminal investigators will step up probes into possible fraud involving collateralized debt obligations and credit default swaps, a top federal prosecutor in New York said.

Christopher Garcia, chief of the Securities and Commodities Fraud Task Force in the U.S. Attorney’s Office in Manhattan, told white-collar criminal-defense lawyers at a conference today that his office will spend this year investigating possible fraud involving CDOs and CDSs.

“If there’s crime there, we’re going to find it and we’re going to pursue it,” Garcia said at an American Bar Association meeting in San Diego. Investigators won’t be deterred by the complexity of the financial instruments, he said.

CDOs are pools of assets such as mortgage bonds packaged into new securities. Interest payments on the underlying bonds or loans are used to pay investors.

UBS is re-filing its lawsuit against distressed hedge fund firm Highland Capital claiming the firm did the Swiss bank out of $686 million in a CDO deal.

The new case, filed Monday in New York State court, is reminiscent of the SEC’s case against Goldman Sachs over a CDO deal gone bad. However, in the UBS case, it is the bank that is claiming to be the wronged party.

UBS is alleging that Highland didn’t tell it about some of its counterparties’ weaknesses when the bank consented to restructure the CDO deal after losses started piling up 2007.

Highland Capital, the investment firm founded by James Dondero and Mark Okada, failed to fulfill terms of the deal reached in April 2007, UBS said in a breach-of-contract lawsuit filed today in state court in Manhattan. UBS Securities LLC, a UBS unit, agreed to arrange the transaction and serve as placement agent, according to the complaint.

After the original transaction expired in early 2008, the parties restructured the agreement in March 2008, UBS said. UBS and Dallas-based Highland Capital agreed that the fund and a special holding company would bear 100 percent of the risk of losses, according to the lawsuit.

“UBS has suffered losses of no less than $745 million as a result of the depreciation in value of the warehoused collateral obligations and credit default swap obligations that it assumed in connection with the failed CDO transaction,” Zurich-based UBS said in the complaint.

Because of declining market values for the portfolios and collateral in September and October 2008, UBS said it required Highland to produce additional collateral. Highland offered “certain securities” that UBS rejected, according to the complaint.

They’re baaaaack. Those toxic and worthless colllateralized debt obligations (CDOs) that helped drive banks $400 billion into the red are finding new buyers under a different name: Re-Remics.
Due to the global credit crunch, CDOs sales fell from $227 billion in 2007 to $1 billion this year so Goldman Sachs, J.P. Morgan and at least six other brokerage firms are repackaging unwanted mortgage bonds into Re-Remics. Re-Remic stands for “resecuritizations of real estate mortgage investment conduits,” the formal name of mortgage bonds. Re-Remics supposedly has parts that are structured to guard against higher losses than most CDOs and would allow investors to sell or keep other parts at lower prices that can translate to potential yields greater than 20 percent. For example, a bond trading at 40 cents on the dollar could be split into a piece worth 80 cents and another piece that could then be sold cheaply enough to offer returns as high as 20 percent.
Re-Remics are different from CDOs in some way. Re-Remics are composed of AAA-rated bonds backed by Alt-A mortgages issued to high quality borrowers instead of debt or credit-default swaps based on the lowest-ranking sub-prime mortgage-bond classes. And while CDOs are backed by more than a hundred bonds, Re-Remics typically combine fewer than a dozen which makes it easier and quicker for investors to separate the better debt from the riskier debt.
According to investment experts like Paul Colonna at GE Asset Management, these Re-Remics are just a different version of CDOs; the mechanics are the same but the valuation levels are different. Colonna said GE has considered buying the debt and might make some of its riskier bonds into re-remics. Analysts also think Re-remics may help revive the market for new home-loan debt by moving illiquid bonds to interested buyers.

Firms like Goldman Sachs, J.P. Morgan and Lehman Brothers all hold significant residential-mortgage securities on its books and this restructuring with Re-Remics could throw them a lifeline. These banks can increase the total credit quality of their assets by selling off lower-rated pieces and keeping the better pieces. So, banks are buying the lower-yielding senior pieces and some are also considering buying the bonds for their pension funds. Companies like Transamerica Life Insurance and Reliance Standard Life Insurance also bought Re-Remics this year.

In the first five months of 2008, more than $9.3 billion of Re-Remics were created – triple from a year ago. Re-Remics made up 47 percent of mortgage bonds issued in the period, excluding those guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae.

Fund managers and banks are under scrutiny for their methods in valuing illiquid securities, after some funds admitted they’re having trouble putting a price on complex debt instruments backed by residential mortgages and corporate loans.

Units of French bank BNP Paribas SA (BNPQY) and insurer AXA SA (AXA) have suspended redemptions on some of their funds because they said they couldn’t value them accurately, while the U.S. Securities and Exchange Commission is reportedly checking the books of U.S. brokerage firms and banks to make sure they aren’t hiding losses by misvaluing assets linked to subprime mortgages.

On Tuesday, Sentinel Management Group, a firm managing short-term cash for commodity trading firms and hedge funds, also halted client redemptions because it said it couldn’t meet them “without selling securities at deep discounts to their fair value.” The firm invests in government and corporate securities.

The lack of confidence in how funds and banks are valuing their subprime exposure – and fear that future risks haven’t been accounted for – has already led to a wave of fund redemptions by investors and a sell-off in some banks’ shares.

The securities in question are known as collateralized debt obligations, or CDOs, and are widely held by banks, insurers, pension funds and investment funds. Backed by large pools of mortgages, loans or other interest-bearing assets, these securities played an instrumental role in fueling cheap credit to home buyers, companies and other borrowers over the past several years.

The breakdown in valuing them is just one effect of the wider credit crisis that started with a sharp and unexpected rise in the number of U.S. homeowners defaulting on their mortgages.

The losses hit CDO portfolios stuffed with risky mortgages, and some funds holding CDO securities became forced sellers to meet margin calls. Investors lost their confidence in the vehicles’ underlying assumptions about default rates, and the trading value of CDOs has tumbled across the board, whether they are exposed to defaulting mortgages or not.

Bear Stearns Cos. told investors in its two failed hedge funds that they’ll get little if any money back after “unprecedented declines” in the value of the securities used to bet on subprime mortgages.

“This is a watershed,” said Sean Egan, managing director of Egan-Jones Ratings Co. in Haverford, Pennsylvania. “A leading player, which has honed a reputation as a sage investor in mortgage securities, has faltered. It begs the question of how other market participants have fared.”

Estimates show there is “effectively no value left” in the High-Grade Structured Credit Strategies Enhanced Leverage Fund and “very little value left” in the High-Grade Structured Credit Strategies Fund, Bear Stearns said in a two-page letter. The second fund still has “sufficient assets” to cover the $1.4 billion it owes Bear Stearns, which as a creditor gets paid back first, according to the letter, obtained yesterday by Bloomberg News from a person involved in the matter.

Bear Stearns, the fifth-largest U.S. securities firm, provided the second fund with $1.6 billion of emergency financing last month in the biggest hedge fund bailout since the collapse of Long-Term Capital Management LP in 1998. The losses its clients now face underscore the severity of the shakeout in the market for collateralized debt obligations, or CDOs, investment vehicles that repackage bonds, loans, derivatives and other CDOs into new securities.

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